How Limited Oil Supply can lead to a Continuing Financial Crisis

I recently wrote an article called Oil Supply Limits and the Continuing Financial Crisis, which has been accepted by the journal Energy. It is still in pre-publication status, but the corrected proof is available for purchase. Because of copyright limitations, I can’t reproduce the article, but I wanted to at least provide a summary.

When I submitted the article, I was asked for five highlights. These are the ones I submitted:

  • Reduced oil consumption leads to lower economic growth and less capacity for debt.
  • Lower capacity for debt leads to debt defaults, reduced credit, falling home prices.
  • Oil supply limits appear to be a primary cause of the 2008–09 recession.
  • If world oil supply remains level, more recession can be expected in OECD countries.
  • Inadequate demand for high-priced oil is likely to cause much oil to be left in place.

I also submitted an abstract:

Since 2005, (1) world oil supply has not increased, and (2) the world has undergone its most severe economic crisis since the Depression. In this paper, logical arguments and direct evidence are presented suggesting that a reduction in oil supply can be expected to reduce the ability of economies to use debt for leverage. The expected impact of reduced oil supply combined with this reduced leverage is similar to the actual impact of the 2008–2009 recession in OECD countries. If world oil supply should continue to remain generally flat, there appears to be a significant possibility that oil consumption in OECD countries will continue to decline, as emerging markets consume a greater share of the total oil that is available. If this should happen, based on these findings we can expect a continuing financial crisis similar to the 2008–2009 recession including significant debt defaults. The financial crisis may eventually worsen, to resemble a collapse situation as described by Joseph Tainter in The Collapse of Complex Societies (1990) or an adverse decline situation similar to adverse scenarios foreseen by Donella Meadows in Limits to Growth (1972).

An outline of my paper is as follows.

  1. Introduction
  2. Reduced oil supply is likely to result in reduced or negative economic growth
  3. Timing and nature of constriction of oil supply
  4. Oil prices do not rise without limit, and oil limits may appear as an “oil glut”
  5. Differences between a growing economy and a declining economy
  6. Some examples showing ties to the 2008-2009 crisis
  7. Possible future scenarios
  8. Conclusion

Below the fold, I explain what the sections cover.

1. Introduction

While oil supply has been roughly level since 2005, neither increasing or decreasing, there is disagreement regarding what the future will hold. In this paper, we consider the scenario in which (1) world oil supply fails to increase, and (2) emerging economies continue to grow rapidly, creating a shortage of oil that acts as a bottleneck for economic growth for OECD countries. This would seem to be similar to the situation that occurred in the 2005-2009 period.

2. Reduced oil supply is likely to result in reduced or negative economic growth

This connection can be seen both through logical reasoning and through academic studies. When oil is in short supply, gasoline and diesel prices tend to rise. The price of food also tends to rise, since oil products are used in producing food. The price of other goods using oil in their manufacture or transport are likely also to rise. People’s salaries don’t rise to match the rise in oil prices, so it becomes necessary for consumers to cut back on discretionary purchases.

In some cases, interest rates may rise as well. In the 2004 to 2006 period, the Federal Reserve raised target interest rates, mentioning rising oil and food prices as a concern. Since salaries do not rise in response to higher interest rates, people’s salaries are likely to be further squeezed by the higher interest rates.

In response to these stresses, consumers could be expected to cut back in many ways. Purchases of new cars and of more expensive homes would be expected to decline, leading to layoffs in auto manufacturing and declining home prices. Consumers would be expected to go out to restaurants less, take fewer vacations, and make cutbacks in other areas that we consider “discretionary spending”. Some may even default on their loans.

According to James Hamilton, all but one of the 11 recessions since World War II have been associated with oil price spikes.

There are many other academic studies showing a connection between oil or energy and economic growth. For example, Dave Murphy and Charles Hall conclude that there is a fundamental limit to economic growth, in that increasing oil supply will require high oil prices, and these high oil prices will in turn undermine economic growth.

3. Timing and nature of constriction of oil supply

World oil supply has been very close to flat since 2005, despite much higher oil prices than in the period prior to 2005 (Figure 1).

Figure 1. World oil production, compared to Brent price, based on EIA data.

Oil consumption of emerging market countries (which I will define for our purposes as the world, minus the Former Soviet Union, and minus the OECD countries) has been rising rapidly (Figure 2). Since world oil production has been close to flat, the rise in emerging market consumption leaves less for everyone else.

Figure 2. Oil consumption, split between OECD, the Former Soviet Union, and Emerging Markets, based on BP Statistical Data

Oil consumption of OECD countries reached a peak in 2005, and declined between 2005 and 2009, rising again in 2010. The timing of the decline in OECD oil consumption corresponds closely to that of the great recession, with the big declines occurring in 2008 and 2009. Emerging markets, with their rising oil consumption, did not experience recession during this period.

If oil production should remain flat, and if demand from emerging markets (such as China, India, and Middle Eastern oil exporters) should continue to grow, there would appear to be a significant chance that OECD consumption may again fall in the future.

(Note: These graphs are slightly different from those in the paper to avoid copyright issues. They also show more up-to-date data than in the paper.)

4. Oil prices do not rise without limit, and oil limits may appear as an “oil glut”

Quoting from the paper:

In this section we will show that oil prices don’t rise without limit. The constraining factor holding production down is often inadequate demand for high-priced oil, rather than inadequate supply of such oil. The result is what appears to be a “glut” of high-priced oil on the market. If oil were inexpensive, there would be plenty of demand for oil.

Whether or not oil prices can continue to rise indefinitely is important, because if oil prices can rise indefinitely, then there would seem to be a substantial chance that the entire amount of oil resources that have been identified can actually be extracted and used. But if oil prices can only rise to a price of $x before recession sets in, then the majority of oil resources which cannot be economically produced for a price of $x or less will be left in the ground unless at some point in the future, conditions change materially.

Besides high oil prices causing recession, the other issue I identify is the fact that at some point, the price paid for oil will exceed the value received from the oil. It takes oil and other scarce goods to extract the oil. Besides direct costs, the economy will need to keep up its roads, schools, and health care systems, to provide a suitable environment for the workers in the oil system. If too much is spent on oil, there will not be enough funds left for needed services to extract the oil. The equilibrium point will be different, depending on the level of services a country provides. A country such as the US with extensive roads, schools and health care services, would be expected to have a lower equilibrium point (maximum oil price) than a country with less extensive services, such as China or India. This may explain why the oil consumption of emerging market countries can continue to rise, when OECD countries find themselves in recession.

The likely pattern to be observed in oil prices is oscillation–rising oil prices until recession sets in, followed by a decrease in both oil prices and consumption. Eventually, demand rises again, as do prices, until recession sets in again.

5. Differences between a growing economy and a declining economy

In a growing economy, it is much easier to repay loans with interest, because the economy is expanding. If the economy is flat or declining, it is much more difficult.

Figure 3. Two views of future growth

In the article, I describe the relationships algebraically.  The basic issues are the same ones I wrote about in my articles The Link Between Peak Oil and Peak Debt – Part 1 and The Link Between Peak Oil and Peak Debt – Part 2.

In this section, I also talk about how a growing economy generates many types of positive feedback loops. Increased debt as well as the growing economy encourage growth in demand for goods and services. Layoffs are relatively rare. Business margins are good, because sales volumes are high relative to fixed costs. Government revenue rises, since tax revenue reflects the prosperity of individual citizens and business owners. Home prices rise because workers can afford to “move up” to more expensive homes. Stock market prices also rise, because of a belief that the favorable conditions will continue indefinitely. It is also relatively easy to borrow money for new investment, so new businesses are formed, further helping employment.

A declining economy works in pretty much the opposite way. With declining demand, the amount of loans outstanding tends to drop (because both borrowers and lenders recognize that it will be harder to repay the loans in a contracting economy, and because businesses have less need for loans to underwrite expansion, when the economy is contracting).

With flat or declining demand and declining loans outstanding, demand for goods and services tends to decline. Layoffs become common, and business margins narrow. Home prices tend to drop, because few people want to move up to more expensive homes, and some may want to move in with friends or relatives. Stock market values are likely to decline, because business prospects decline. Lenders become less willing to offer loans for new investments, because the possibility for repayment are worse. Tax revenues are likely to decline, causing governments to find themselves in increasing financial difficulty.

6. Some examples showing ties to the 2008-2009 crisis

Consumer credit outstanding peaked in July 2008 (Figure 4). That is precisely the month oil prices reached a peak and began to decline.

Figure 4. US consumer credit outstanding, based on Federal Reserve Data

Although I have not shown a graph here, there is a similar relationship with home mortgage loans. The amount of home mortgage loans reached a peak in early 2008, and has been declining every quarter since then.

The downturn in home prices in early 2006 also seems to come at the time one would expect, given rising oil and food prices, and rising interest rates. The rise in oil prices started as early as 2004, (Figure 1) and the Federal Reserve’s response was to raise target interest rates in the 2004-2006 period. While oil prices continued to rise after 2006, sub-prime housing was the “weak link,” and was affected early on by higher oil and food prices together with higher interest rates.

This [the downturn in home prices] came at a time when oil prices were rising, and these higher oil prices affected home-buyers available income, especially in the outer suburbs, where the problem was noticed first.

The US Federal Reserve, in its minutes, specifically referenced rising oil and food prices as reasons for raising target interest rates (Ludlum) [22]. When oil prices rose and interest rates also rose, a reduction in housing demand occurred, which helped prick the sub-prime mortgage bubble.

7. Possible future scenarios

I see three possible scenarios:

Scenario 1. World oil supply again begins to increase, and OECD gets enough of this increase so that its consumption starts increasing. There would be a possibility of few problems, if this should occur.

Scenario 2. There is an increase in world oil supply, but OECD countries are unable to compete for it, or refuse what is available. The outcome can expected to be poor, even if the reduction is voluntary.

Scenario 3. World oil production is flat or declines. It seems likely that OECD will continue to be outbid for oil, and further recession will be likely.

8. Conclusion

We seem to be reaching limits on the amount of oil the world can extract, at prices OECD countries can afford to pay. There appears to be a real possibility that OECD’s oil consumption will continue to decline, and that OECD countries will continue to experience recession and debt contraction.

This could all end very badly. Banks, insurance companies, and pension plans would be adversely affected if debt is not repaid as promised. At some point, the financial system and international trade would appear to be at risk of disruption. Both Tainter (The Collapse of Complex Societies) and Meadows (Limits to Growth) describe adverse scenarios, in which all systems seem to deteriorate at the same time. While we don’t know for certain that the outcome will be of this type, we should be considering this possibility.

Some have suggested that a steady state economy can be developed which will prevent collapse, and allow the world to live at a lower but acceptable level. Research is needed as to whether this is really feasible. It may be that the population which can be supported with a steady state economy does not differ materially from a collapse scenario.

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to inadequate supply.
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52 Responses to How Limited Oil Supply can lead to a Continuing Financial Crisis

  1. RobM says:

    Nice paper. I agree the 2008 economic crisis and oil are linked but perhaps in a slightly different manner than you suggest. Competition for constrained supplies flattened our energy consumption starting in the 90′s. As per Timothy Garrett, real wealth is proportional to energy consumed. With real wealth flattening, we maintained the illusion of growth with additional debt (aka paper wealth). As per Steve Keen, increasing debt works until some threshold is reached at which point the system becomes unstable and then unwinds to a debt level below that when the cycle began. In summary, the core problem today is too much debt and the reason for too much debt is we want to be richer than available oil permits.

    • I don’t really disagree with this analysis. Our real wealth has stopped rising. One way this drop in wealth is felt is though fewer people having jobs (because oil is required in many ways–to perform many jobs, for transport to the job, and because people who earn $$ use this to buy oil-related products). Partly to overcome the lack of oil and partly to disguise the lack of real growth, we have transferred many jobs to the emerging markets (China, India, etc.), where laborers use less oil (walk or ride bikes to work and buy few goods made with oil). Increased debt has also been used to disguise our problem, but without growth, it will be impossible to pay much of it back.

  2. phil harris says:

    Gail
    I tend to agree with RobM.
    But you generalize toward possible historical comaprisons (Tainter) or combined-resources constraint scenarios (Meadows).
    Capitalism as combined with industrialization is a modern phenomenon (300 years) and has seen long term expansion and ‘economic growth’. (Previous pre-industrial systems saw expansion, and sometimes exuberant prosperity, and collapse, but probably not ‘growth’ as we have learned to define it in our industrial economies?)
    ‘Boom and Bust’ was a cyclical feature of capitalism in the 19thC and in the increasingly globalized 20thC, well before ‘oil’. ‘We’ kept growing though. Arguably, ‘oil’ allowed for continued and faster ‘expansion’ and ‘growth’, but only in a big way after the 2nd half of 20thC, Competitive ‘making of money’ has been from the beginning the economic strategy that ‘did the math’, and counted the failures as well as successes of expanding goods and services. On the other side of the coin, competition restrained the global majority from accessing the majority of the ‘proceeds’. Ancient economic strategies indeed were in many cases dismantled as capital sought ‘resources’, especially latterly oil; hence ‘uneven development’. Interestingly we have witnessed similar rapid dismantling within OECD countries themselves, perhaps especially the USA in the last 40 years, of both societal and industrial structures, in order to follow the direction of the ‘math’. A different world at home as well as abroad, just in your and my lifetime?

    The following is in support of your thesis perhaps? ‘Oil’ is now 40%(?) of world energy and complex transport and arbitraged(?) labor are ever more the hallmarks of the globally directed capital structure. At some point(s) the tendancy to ‘boom & bust’ (the math) intersects with reality of permanent resource constraints? For example, the ratio of the returns on CAPEX invested in ‘oil’ has down-turned dramatically I believe over the last 10 years. Real prices appear to have met real geological difficulty when trying to maintain expansion.

    ‘Making money’ thus begins to appear to me an inadequate long term economic strategy at best, and as the driving competitive math, becomes a foot on the wrong pedal as we approach the wall? Even OECD ‘losing’ the competition with emerging markets is not going to ‘hack it’, even medium, let alone long term?
    best
    phil

    • My article is fairly short, and doesn’t get into a lot of other things that might be brought up. I have submitted a draft of a book under a contract with Springer on a similar subject. It gets into more issues, but even at that, it does not cover everything.

      I think an argument can be made that from the time man discovered fire, there has been at least some growth in the resources consumed by man, and in the ability of the earth to support more individuals. In the last 200+ years, however, we have used non-renewable resources to produce an unprecedented growth rate. My theory is that the maximum oil production/consumption is really tied to financial issues, partly because of the connection of price and EROI, and partly because we have so much debt, and this debt must be supported by economic growth, to prevent high default rates. We are now facing an unprecedented situation–having to go from growth to decline. The whole structure of our society (political structure, international trade, large utility companies, abundant well-kept roads) depends on maintaining our energy supply. A major cutback could disrupt many areas as once.

  3. phil harris says:

    Note to my comment above.
    By ‘returns’ on CAPEX invested in oil, I mean ‘return’ in the form of oil pumped from the ground. Oil companies still seem to be doing well making money just now!
    phil

  4. Shunyata says:

    To Phil Harris:
    There are two systems at work here:
    (i) a physical system that furnishes raw materials, finished goods, and services.
    (ii) a financial system that allocates the fruits of the physical system.

    Boom-Bust can occur EITHER when the physical system breaks down or when the financial system breaks down. The 20th century events were almost entirely financial – the financial system was manipulated to extract money from naive participants. Gail is suggesting the the current situation is something new – the physical system is unable to provide raw materials, finished goods, and services.

    If the physical system IS capable of providing sufficient produce, then we will eventually restart the process of allocation, production will resume, and the crisis will be deemed “passed”. If the physical system IS NOT capable of providing sufficient produce, then the old system of allocation cannot work and cannot restart. (Our system of debt constantly expands the money supply, requiring constant economic growth to backfill the new money.) In this case limited production will eventually resume; new allocation approaches will be adopted, and we will deem that we have “transitioned”.

    • Tom Murphy (a physics professor at University of California, San Diego) has an interesting argument on why physical growth cannot go on forever, and on why economic growth cannot be separated from physical growth. Regarding physical growth going on forever, he argues in Galactic Scale Energy that the world would physically become too hot for this to happen. He tackles why economic growth cannot be separated from physical growth in Can Economic Growth Last? particularly in the section called “The Unphysical Economy”. He argues that if growth is entirely transferred to the unphysical economy, then the funding for the physical economy (food production, oil extraction, etc) will need to decline to get adequate growth from the other sectors.

      The important result is that trying to maintain a growth economy in a world of tapering raw energy growth (perhaps accompanied by leveling population) and diminishing gains from efficiency improvements would require the “other” category of activity to eventually dominate the economy. This would mean that an increasingly small fraction of economic activity would depend on energy, so that food production, manufacturing, transportation, etc. would be relegated to economic insignificance. Activities like selling and buying existing houses, financial transactions, innovations (including new ways to move money around), fashion, and psychotherapy will be effectively all that’s left. Consequently, the price of food, energy, and manufacturing would drop to negligible levels relative to the fluffy stuff. And is this realistic—that a vital resource at its physical limit gets arbitrarily cheap? Bizarre.

      This scenario has many problems. For instance, if food production shrinks to 1% of our economy, while staying at a comparable absolute scale as it is today (we must eat, after all), then food is effectively very cheap relative to the paychecks that let us enjoy the fruits of the broader economy. This would mean that farmers’ wages would sink far lower than they are today relative to other members of society, so they could not enjoy the innovations and improvements the rest of us can pay for. Subsidies, donations, or any other mechanism to compensate farmers more handsomely would simply undercut the “other” economy, preventing it from swelling to arbitrary size—and thus limiting growth.

      • Les D. says:

        “This scenario has many problems. For instance, if food production shrinks to 1% of our economy, while staying at a comparable absolute scale as it is today (we must eat, after all), then food is effectively very cheap relative to the paychecks that let us enjoy the fruits of the broader economy. This would mean that farmers’ wages would sink far lower than they are today relative to other members of society, so they could not enjoy the innovations and improvements the rest of us can pay for. ”

        But isn’t this what countries like the U.S. have been doing for the last century? I can’t find the exact figures, but I seem to remember that agriculture in the U.S. is about 3% of the economy, and uses about 2% of the energy. Yet the U.S. is the world’s largest food producer, as well as the world’s largest food exporter. All we need to do is shrink the parts of the economy that use the other 98% of the energy (except for the energy sector itself, which uses perhaps 5% of the energy) and expand the “activities like selling and buying existing houses, financial transactions, innovations (including new ways to move money around), fashion, and psychotherapy” to employ the people put out of work.

        • According to this USDA bulletin,

          As a share of the national energy budget, food-related energy use grew from 12.2 percent in 1997 to 14.4 percent in 2002.

          So energy expenditures are much higher than you remember.

          According to the BEA, food purchased for off-premesis consumption amounts to about 7.7% of personal consumption expenditures. Personal consumption expenditures are lower than GDP. If we recalculate, using the new base, food purchased for off-premesis consumption is about 5.6% of GDP.

          Adding restaurant food would raise these percentages.

    • phil harris says:

      To Shunyata
      Thanks for your thought.
      From what I see though, the financial system does not only/just allocate the fruits of the system. Through competitive investment the FS directs or influences which physical systems grow and which decline. (This can often mean mal-investment, or just plain waste, when viewed in the appropriate time-frame. But expanding market access to a resource like oil “can lift all boats”, as Gail put it recently, whatever the losses along the way.)

      With regard to investment specifically in oil and NG resources, as ‘Rockman’ of The Oil Drum keeps pointing out: “if it will not make money it won’t happen”. He also keeps pointing out, apparently paradoxically, that there are some strange ways that ‘making money’ can be manifested. He quotes companies in the US that he worked for whose share price (via Wall Street) had increased mightily, attracting ‘investment’ on the basis of ‘prospects’, that quite rapidly went bust because they could not keep the flow coming. Some people made a lot of money, and some lost a lot, but it all made little difference to the overall downward trend of oil extraction in the USA. Whether USA can continue to compete for its disproportional use of extracted world oil (5% uses 25%; 2/3 imported?) is another matter.
      phil

  5. Gail,

    You do a very good job of boiling down complex concepts into understandable explanations. Kudos.

    But I’m surprised by 2 of your 3 future scenarios. We are really fueled by giant and super giant oil fields. It takes 5 to 7 years from discovery to production on these large projects. We know we aren’t going to see an increase in oil supply during this time frame. Why detail this in 2 of your 3 options? The bigger uncertainties come from 1) how much will demand contract? and 2) how hard will existing field depletion start biting?

    Shouldn’t your future scenarios include a separate contraction of oil supply scenario or 2 since many of us probably consider this the most probable?

    • My problem in this article is that I am dealing with basically a skeptical audience. While it is true that I could separate Scenario 3 into two versions–level oil production or declining oil production, the fact that level world oil production is likely to produce a very bad outcome (economic decline with feedback loops tending toward collapse) from the point of view of OECD is sufficient. In some sense, it doesn’t matter if oil supply declines, because the result appears so bad, even without actual decline in world oil production. My guess is that it will be the economic decline that feeds back and will cause physical decline, at a rate much different from what our models suggest. For example, rising food prices will lead to uprisings in some of the oil producing countries, causing declines in production. This will especially be an issue in countries where oil exports are already dropping.

      • weaseldog says:

        Right, if oil production can’t keep up with economic growth, then it’s in decline, relative to the economy side. In a healthy economy without infinite bailouts, this would lead to a correction, and a temporary recession, until the economics and oil production were in balance again.

  6. weaseldog says:

    From the 1970s on, the first world saw faster gains in resource usage through the IMF’s policy of controlled demolitions in their use of Austerity Programs.

    I still remember a National Geographic layout of a night time view of the whole Earth seen from space in the early 1970s. What surprised me was that Africa wasn’t dark as I expected. It was crisscrossed by major highways and you could clearly see them from the headlight of cars and trucks that lit them up.

    Enter the IMF. The IMF offered cheap loans, on the condition that their bankers be installed to run the economies. the bankers and their friends then stole most of the money loaned to the nations, while privatizing all government infrastructure and ending social programs. then with credit dried up, factories closing, the people became responsible for the money that the bankers stole and austerity programs were enacted that gave away the rest of the country to foreign corporations. Under this plan, foreign corporations operated tax free while local businesses operated under onerous taxes of 30% and more.

    This pattern was repeated in nation after nation. It’s not so much a conspiracy as a business plan.

    The effect was to prevent an entire continent from rising to first world levels and competing for resources.

    Today, because the IMF destroyed Africa, night time views show only lights in the coastal cities. There is no longer a network of lines of light, crisscrossing the interior.

    Had the IMF not destroyed Africa, and then done a great deal of damage to South America, resource competition from the 1970s on, would’ve constrained much the the USA’s growth and wealth after domestic oil production peaked in 1970-1971.

    Effectively, what the IMF engaged in was a program of triage. Or an arborist might call it pruning.

    Today, the USA is repeating many of the policies that African nations engaged in before their fall. The USA has put the bankers in charge of it’s economy. It’s running up massive debt. It’s letting bankers steal incredible sums of money in plain sight and legalizing every theft. It’s closing factories and eliminating jobs at a record pace. And like those African nations, while the people are being starved, the expensive military purchases and the number of wars are on the increase. further, The call for privatization and the exploitation of our remaining resources is becoming a deafening cry.

    We’ve seen exactly what happens when this scenario is played through. The lights go out.

    • I hadn’t really looked at things this way. I know my father grew up in Madagascar, when it was under French rule. Things were much better then. The countries were “liberated” from their colonial masters, and then the IMF came in and “helped.” I have run into pieces of this story previously. I am afraid you are probably right.

    • Ed Pell says:

      Yes, I expect all public assets in the US will be sold off to private owners to pay interest on the debt. Just as was done in Argentina (or as you say Africa). Ownership of the world by a small group of global bankers is the plan. This will allow them to control population by limiting access to jobs, food and water. I image they see them selves as saviors of humanity and the planet. I do not.

      • weaseldog says:

        I think they see it as doing what they have to, to live in the lifestyle in which they are accustomed.

        • Philip says:

          Thanks for your previous comment. I find it interesting and thought provoking, but, unfortunately, not surprising. I don’t quite agree with what you’re saying here, though. Our behavior and our thinking is structured by a variety of constraints. I live in Copenhagen, and the culture and infrastructure here make riding a bike and using public transportation viable alternatives to using a car. Had I been living in the United States, in all probability a car would have been my only option. I’m sure you’re familiar with the story of corporations buying up streetcar networks in American cities, and then eliminating them. At this point in time, the car is not only the only option due to infrastructural constraints, but also the only transportation option that most Americans are capable of thinking of.

          I think something similar applies here. Corporate culture, regardless of personal motives, necessitates or favors certain kinds of behavior and thinking. Corporations are legally bound to maximize shareholder value, and long-term effects, social consequences, environmental externalities are largely irrelevant (unless they interfere with profits).

        • weaseldog says:

          Philip, you’re talking about something completely different. what we are discussing is essentially corporate raiding on a national level. It’s a step up from what the East India Company used to engage in.

          Consider the corporation AquaSource and how they operated in South America. Once the IMF enacted austerity measure in South America, AquaSource bought up public water supplies for pennies on the dollar. They then bribed the legislatures to make private and public water wells and rain water harvesting illegal. they were granted total ownership of all drinking water. Then they raised rates dramatically on water, and cut maintenance. Businesses went under because they could no longer get reliable water supplies. People got sick and died from drinking AquaSource water that had not been treated. Facilities broke down, water mains broke, and no repairs were made.

          Cintas is another corporation that engage in predatory capitalism in Argentina, and is negotiating a deal to buy major US Interstates to turn into toll roads. The IMF arranged for them to buy the railroad system in Argentina for a small fraction of it’s actual value. Thousand of factories and millions of workers depended on the railroads to move goods in the and out the country. After the purchase, Cintas shut down the railroads and tore up the tracks,m selling the rails to China for scrap and the locomotives were shipped to Europe and sold. Thousands of factories were forced to close. Many thousands of children and old people subsequently starved to death for lack of work and lack of transportation to move goods, including food about the country.

          There are many many examples of international predatory capitalism associated with the IMF’s work in destroying economies.

          And on this comment,
          Corporations are legally bound to maximize shareholder value, and long-term effects, social consequences, environmental externalities are largely irrelevant (unless they interfere with profits).

          That is the textbook theory. But in practice corporations operate to maximize profits for those who control the corporation. If shareholder power is largely diluted then the board tends to decide who gets the profits. in the case where a person, family or group owns a majority of shares, they of course can influence what the board does. In this age though, the majority of corporations, see power concentrated in the hands of the CEO and board members and they take in huge profits, because they can.

        • Philip says:

          Hi Weaseldog -

          I thought the “textbook theory” was bad enough, and you’re telling me today’s reality is much worse. Unfortunately, to a great extent, I think you’re right. I know there are figures that show that executives take in x times more than workers. Do you know if there are figures that show the historical development of distributed corporate profits, especially the percentage of those profits, including salaries, bonuses, and stock options, that accrues to the CEOs and the directors. Certainly, the relative growth in the wealth of the top .01% and .001% can, at least in part, be explained by this.

          Having said that though, I would add that capitalism by its nature is a predatory system, and that it has a tendency to exploit whom, what and where it can. This, to me, is what maximizing profits entails, so I don’t think we’re talking about something completely different. You mention the IMF, and the consequences of its policies. I don’t know if you’ve been following ALEC, a home grown collusion of state legislators and corporate representatives that is writing “model laws” designed to facilitate corporate profits by among other things encouraging privatization, weakening workers’ rights, and eviscerating environmental regulations. (You can read about ALEC in The Nation. NPR’s Fresh Air recently had an interview with The Nation’s John Nichols that was followed by a disturbingly revealing interview with ALECs figurehead.) From what I can see, corporate capitalism is ever refining its techniques, and using them, as you might say, where it can.

    • Stravinsky7 says:

      Dude, you are so hardcore.
      ;)

    • Dave says:

      I had never thought of the IMF in this way myself until I read Confessions of an Economic Hit Man by John Perkins. A friend of mine who once worked for one of the alphabet agencies borrowed the book and later came back to me smiling. He said he had forgotten some of the stories, particularly Central America until he read the book. Also ties in with Friends In High Places: The Bechtel Story by Laton McCartney with their alleged ties to the CIA.

      Gail – while you do a better job of just about anyone of looking at the financial side of peak oil and finances in general, I do feel you sometimes hold back from using plain language in how this will affect many people. I am not anywhere near as smart as you in this area, but if I think of the logical conclusion of these things we may not only be at peak oil but peak population.

      • One thing I discovered early on is that many people cannot take the truth, if it is too awful. Kyle Saunders (Prof. Goose) at The Oil Drum pointed out to me that people many just get upset, and respond with long rants, when the truth is too plain and scary. He suggested backing off a little–saying something is a scenario that may occur, even if there is 99% certainty that it really will occur.

        We really don’t know anything with 100% certainty. Some people might take inappropriate actions if they are too frightened of the future. BTW, I think you are probably right about peak population not being very far away.

  7. weaseldog says:

    Back in 1999, I came up with the idea that once global oil production neared it’s peak, that finance would be forced to decouple from the industrial economy to keep growing. In this view finance would increasingly rely on printing money and the complex layering of debts, sometimes, self referencing to keep growing. This would keep producing money in a Ponzi like fashion. I thought at the time that bailouts and government guarantees would be a sure thing, because the collapse would hurt the billionaires and they have the resources to get governments to do their bidding.

    I came up with the silly formula…
    V = E / M

    Where:
    V = Value of Money
    E = Available Energy
    M = Available Money

    This has to be view in the context of a two tiered monetary system. Because the financial system is largely decoupled from the industrial economy, the $trillions washing around really don’t have an effect on industry. What does have an effect is money leaking out of this system and impacting sectors that the financial folks are interested in gambling in.

    Because the money supply at the human level is not growing at anywhere the rate that it is in the financial stratosphere, we’re not seeing Zimbabwe style runaway inflation.

    I guess this is no longer theoretical.

    What this view suggests though, is that a pop in the financial bubble, could unleash a flood of money into the industrial tiers of the economy and do a great deal of damage to the value of money. I don’t know how this might happen. I can’t be sure that it’s possible. After all, the debt far exceeds the quantity of money.

    • Ed Pell says:

      Weaseldog, I am happy to see someone else understands what is happening. It seems so obvious but almost no one talks about it. Thank you.

    • In order to get real inflation, it seems like a person would need to get some of the funny-money back to the ordinary citizens as salaries or quasi-salaries. The problem with jobs going overseas is that many people are unemployed. The government can print money, but it is hard to keep up with the deleveraging in the private sectors and the lack of income from jobs. It seems to me that a lot of the funny-money will simply implode–the debt underlying it will default. Theoretically, the government could try to prop up derivatives, as it did with the AIG bailout, but those derivates don’t really go back to people who need to buy things.

      • weaseldog says:

        I agree Gail. It looks like the trend for the USA is the African plan. The runaway inflation won’t happen until after the economy has been completely hollowed out and dropped from the international system.

        I would expect this will occur sometime after we start seeing serious defeats in our expanding wars. See Sun Tzu and the USSR after Afghanistan.

    • RobM says:

      Timothy Garrett has quantified and validated your theory.
      $1 US (1990) = 9.7 mW
      http://www.inscc.utah.edu/~tgarrett/Projects/Economics.html

      • weaseldog says:

        Nobel Prize Winning Chemist, Frederick Soddy, beat us both. I learned about him after writing on this topic on the Yahoo Group EnergyResources.

        I think it’s an interesting anecdote that 19th century scientists appear to have understood how the world works, much better than most college graduates. Our education system seems to be able to get most folks up the to 18th century in understanding, but no further.

        • RobM says:

          Energy leads to wealth. Wealth leads to complexity. Complexity requires specialization. Specialization discourages systems thinking. Systems thinking is required to understand our predicament. And we are genetically inclined to be optimistic about the future and thus frequently lie to ourselves to remain optimistic.

          Wikipedia on Soddy: In four books written from 1921 to 1934, Soddy carried on a “quixotic campaign for a radical restructuring of global monetary relationships”, offering a perspective on economics rooted in physics—the laws of thermodynamics, in particular—and was “roundly dismissed as a crank”. While most of his proposals – “to abandon the gold standard, let international exchange rates float, use federal surpluses and deficits as macroeconomic policy tools that could counter cyclical trends, and establish bureaus of economic statistics (including a consumer price index) in order to facilitate this effort” – are now conventional practice, his critique of fractional-reserve banking still “remains outside the bounds of conventional wisdom”.

          I fear this suggests we can be right about the destination but grossly wrong about how long it will take to get there. I have upended my personal life on the assumption that huge changes are imminent. Sure hope Wikipedia is not writing about our predictions 80 years from now.

        • weaseldog says:

          RobM, haven;t you been seeing huge changes in the world?

          Unless a new Start Trek Style Free Energy source is given to us by travelers from the Planet Vulcan, civilization will be fully collapsed in eighty years. Our current cheap and easy energy supplies can’t last that long at any substantial production rates.

          On the personal level we’ll see a gradual ratcheting until the USa experiences it’s own Perestroika event. But Russia had plentiful oil supplies left for their recovery. The USA will have nothing.

          YMMV….

      • weaseldog says:

        Oh, and thanks for the link. :)

      • Robert Happek says:

        The equation $1 US (1990) = 9.7 mW does not really make sense. It arises from the assumption that GDP is measured in Dollars mutliplied by time. I think this is wrong. GDP is the sum of a certain number of Dollars within one year – the result is again measured in Dollars, not in Dollars times one year. If at all. the equation should read $1 US = 9.7 mWh.

        Consider solar panels producing electricity. The total cost of such a panel (including inverter and installation) runs between $3 and $10 per Watt. At $10 per Watt this is at least one order of magnitude higher than the quoted figure. Or buy a new car for $20,000, fill up the tank for $60.and empty it on a highway. This exercise comes down to $1 US = 5 Watts – almost three orders of magnitude higher than the quoted figure.

        • RobM says:

          I too initially thought that the rate of energy consumption should be proportional to the rate of wealth generation. In fact Garrett shows that the rate of energy consumption is proportional to total wealth (i.e. the integral of GDP). It made sense to me when I thought about the energy required to maintain an asset. In the absence of maintenance (energy) assets revert to zero value. Therefore as our wealth accumulates we consume more energy. This it seems to me is pretty profound. It may suggest that things will unwind a lot faster than even some doomers predict when energy starts to decline in earnest.

          Suggest you read Garrett’s papers (or watch his video lecture) because he explains things much better than I can.

        • weaseldog says:

          You have some good thoughts on this topic.

          There are a couple points I think we need to dig deeper into.

          For instance, for solar panels, we need to look not at the potential energy of listed on the package, but the actual energy returned by actual use of the product. It may say 5 watts on a panel, but that’s 5 watts when the sun is shining, and it’s installed, and you have a load on it. When you’re not using it, and it’s not performing work, it doesn’t add to available energy.

          Further, you need to subtract the sunken costs in energy needed to produce the panels. For instance the energy costs used by the furnaces to purify and crystallize the silicon wafers, needs to be subtracted.

          We call this, Energy Returned on Energy Invested.

          Gasoline is a good choice to consider because it’s fuel it’s in final form, ready to perform work. Crude isn’t generally used raw to power machinery or furnaces. It must be refined first. This adds additional energy costs. If you really want to dig into minutiae, then you’d add up the BTUs or watts that actually end up performing work.

          In the end it’s not the cost to purchase the energy that is important. We’re used to looking at energy that way. What ultimately matters is profit per watt. But this is going off tangent a bit.

          Looking at the other end of the telescope is difficult, because we don’t generally make measurements this way. We can also get into endless bickering over details of what to include and not to include. Still V = E / M provides a rough view of the state of things. It assigns the energy that is actually performing work as the primary store of value in our civilization, rather than imperfect measuring commodities such as gold.

          The reason gold works at all is that it’s rate of production was historically steady as was energy production from food and, sun, water and wood,. Over most of our history our available energy came from low yield non varying sources. These were determined by ambient solar energy. In this view, food does count as an energy source. It’s just orders of magnitude lower in scale than oil.

          • Pedro Prieto has done research on Spain’s solar PV installations, and in fact, is an owner himself. He has a presentation up at the Biophysical Economics conference website called How Much Net Energy does Spain’s Solar PV program deliver?

            In his view, there are a lot of costs besides the solar PV that need to be considered. Parts break, and cannot be replaced for months, leaving the system down. There is the risk of theft, which is at least partly covered by insurance costs. The systems also need to be cleaned, to keep up the amount of electricity they produce.

            One of my complaints about most of these analyses is that we really don’t know the lifetimes of these systems, because they are part of the electrical grid system, and last (for most purposes) only as long as the grid lasts. If we cannot repair electrical transmission lines because of oil supply issues, or if there are problems paying workers because of banking problems, the solar panels don’t work as originally installed. In some cases, it may be possible to use them for other purposes–for example, powering a well when the sun happens to be out–but making this change requires quite a bit effort and the availability of a suitable alternate use.

        • weaseldog says:

          It’s early, I’m not thinking quite right.

          Money profits are not a store of value. The value in this equation cums from work done, through the consumption of energy. Adding more money while the quantity of work over a unit of time is constant, dilutes the value of money,

    • Stravinsky7 says:

      V = E / M

      =

      The formula for the oil based monetary system.

      This equation is hugely relevant for currency in oil producing countries. It is one reason I have argued for hedge betting in Saudi currency since I first became peak oil aware (and I understand that their oil reserves are not limitless, but I can practically guarantee you that they will not win the race to the bottom.).

  8. wiseindian says:

    @Gail
    Have you seen the world debt clock ? The debt growth in recent years has been staggering, humanity can no longer wait to buy things with our own earned money, we must buy stuff with borrowed money. It’s like one giant bubble with people and entire countries speculating with easy money. This in itself has profound implications for future.

    • I guess I haven’t looked at the world debt clock, but I think you are right. Most of this debt doesn’t make sense–it might if resources could grow indefinitely, but it doesn’t otherwise. A big piece of debt went to enrich bankers.

  9. C.W. Thompson says:

    Thanks for this excellent article. I’d appreciate your view on the impact of financial speculation on hydrocarbon market price. Do you think that investment banks with highly leveraged electronic money are distorting the market clearing price of oil, for instance? I gather from my reading that producers in the real economy are furious at financial entities (vampire squids?) who have destabilized their futures markets with a tsunami of electronic money.

    • I am not convinced that financial speculation plays a big role in oil prices. We have a basic issue–oil prices need to be quite high, to make extracting oil worthwhile in many parts of the world. Even in the Middle East, where we think of production costs as low, the governments need the proceeds from the sale of oil at a relatively high price to keep their population pacified. (The high price of oil means that food prices are also high. Governments need to subsidize the prices for their population, or face revolt.) Places like Egypt, where the population is very high (80 million) and there are no exports have a real problem, because they cannot afford the needed food subsidies.

      I think that the normal flow of the oil marketplace–buying oil and storing it–has some impact on oil prices. For example, there is too much oil at Cushing, OK, so WTI price tends to be too low. But I have a hard time seeing that financial speculation really does much.

      • RobM says:

        I think of speculation as froth and waves on a tide. It can have an effect but is irrelevant in the longer term.

  10. Ed Pell says:

    Weaseldog, loved your coverage of Argentina. Thanks.

    • weaseldog says:

      Thanks Ed.

      I started paying attention to Argentina back in 1999 when I realized that all economies are underwritten by energy. This understanding gave men insight into why nations fail, and then I became aware through my personal research that the IMF was destroying nations right after they hit their resource peak. The pattern isn’t 100%, but it correlates too strongly to be coincidence. I then started trying to understand what they had in common.

      With data from Colin Campbell on nation by nation depletion curves, I predicted the IMF would take down Argentina in 2001, and they did.

      the destruction of the USA took longer to get rolling, but it’s moving at a good clip now.I suppose that the IMF has been too busy in other countries to do a proper hack job on the USA until the last six years or so.

  11. Anonymous says:

    Hi Gail. I was just wondering why you submit papers to journals with such restrictions, much less ones by Elsevier which has been plagued by scandals. Since you have this blog and are interested in getting people informed, I would have guessed you’d be a supporter of open-access journals. I don’t know the various journals in this field, but I imagine there must be some open-access ones. Please don’t take this the wrong way, I’m not criticizing you for this, I’m just curious what your thoughts are about where to send articles and why.

    • Since I am not an “academic,” my inclination is to stay away from journal articles all together, but I do end up doing them, when I get involved with a group of folks who are have a particular interest.

      With respect to this journal article, I gave a talk in Barcelona at a conference in October 2010. Several of us agreed to do write-ups of our talks for Energy (or updated versions of our talks) after the meeting, and got assistance from others. Mario Giampietro was one of the leaders of this conference.

      I have recently worked on an article with respect to China hitting coal limits (price and quantity) with a couple Chinese authors. It is up to them exactly where this gets published.

      • Dave says:

        Gail – Now that you put it that way, you are right. I am not trying to reach a broad audience with my beliefs whereas if you paint too stark a picture you will lose people and thus not have the opportunity to engage them in thinking about the issues at hand.

  12. and every day that ends like this
    we bless in whispers to our children kissed
    tomorrow maybe then they’ll die
    tonight they’re here don’t let them cry

    http://thepeakoilpoet.blogspot.com/2011/07/just-hold-this-child.html

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